The St. Louis Fed (FRED) graph of corporate profits as a percentage of Gross Domestic Income (GDI), a good proxy for gross domestic output (GDP), explains much of what boosted inflation during the COVID pandemic. The product shortages and supply chain shortcomings caused the sudden scarcity of goods, but not the sky-high retail inflation that consumers in particular experienced.
Corporate profits accounted for the largest share of the price hikes experienced since the pandemic. Data from the U.S. Commerce Department shows that 2021 corporate profit margins were the largest they've been in 70 years, some 16.7 percent in 2021, the last year annual profit data was available.
That is why consumer CPI inflation surged in 2021 and is slowly returning to more normal levels. You name it—food service and energy companies took advantage of the sudden shortages in their efforts to maximize profits.
The Consumer Price Index (CPI) rose just 0.2 percent in July, and the yearly rate of inflation rose to 3.2 percent from 3 percent in the prior month, the consumer price index showed. It was the first increase in 13 months.
The core rate without food and energy prices over the past year slowed to 4.7 percent from 4.8 percent and is the lowest rate in almost two years.
However, a large share of the remaining core inflation includes housing rents and used car prices that have remained stubbornly high. Since when is the Fed responsible for bringing down rents and car prices? These prices are controlled by intermediaries like realtors and auto dealers that want to maximize their own profit margins, not by the Fed.
There is also a surge in business productivity reports Brian Bethune, a Boston College economics professor. Business productivity jumped by 3.7 percent while unit-labor costs rose just 1.6 percent.
“At the same time, overall prices increased by 2.2% — well within the U.S. Federal Reserve’s target and the lowest inflation rate since the second quarter of 2020,” said Professor Bethune.
U.S. corporate profit margins have been excessive, said Bethune.
“In other words, there was “profitflation” — also known as “greedflation,” The ability of industry to raise prices aggressively, rather than defensively, is tied to increasing business consolidation and more mergers and acquisitions. Indeed, bank takeovers resurfaced in the first half of 2023 under severe liquidity stresses created by higher short-term interest rates; that story is not yet over.”
The inflation battle has been largely won, and corporate profit margins are declining as supply chains catch up to demand. Profits declined – 4.1 percent in Q1 2023, according to the Bureau of Economic Analysis (BEA).
Consumer spending is tapering as well that has been the main cause of said demand, so that personal consumption expenditures (PCE) were up 5.4 percent YoY in June, down from the post-pandemic high of 13.1 percent in 2021.
Consumers provided most of the 2.4 percent increase in Gross Domestic Product (GDP) in the ‘advance’ (first of three) estimates of second quarter economic growth.
The story is not over for the Fed’s battle with inflation, either. High interest rates that are crimping corporate profits as well as consumer spending will continue to bring down the inflation rate. But we don’t want outright deflation China is experiencing that is causing massive unemployment among its youth.
We cannot really afford another recession, such as happened in 2007-09, or might happen again if the Fed continues to boost interest rates.
Harlan Green © 2023
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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